We should all be thrilled about higher prices

Opinion: That’s a sign the economy is back on track for good

We received news this week that U.S. consumer prices modestly increased in March, driven in large part by food, energy and housing costs.

In some corners of the blogosphere, that was seen as a warning that inflation is accelerating, something that could lead to a correction in stocks.

Baloney.

Sure, the fact that the Consumer Price Index was up 0.2% in March, topping forecasts, is noteworthy, especially after a 0.1% rise in CPI from February. Even more noteworthy is the fact that core CPI was up 0.2% too, even when you back out volatile food-price swings driven by drought or energy prices that spiked, thanks to prolonged winter weather.

But a sign that inflation has moved up isn’t a cause for alarm.

I mean, gold is back around $1,300 an ounce after a short-lived rally in March. That suggests metals traders brushed off the CPI report.

Rather than buy the fear mongering about inflation, investors should be actually be thrilled by rising prices.

In particular, March CPI is encouraging because it shows that the threat of deflation at home seems much less severe — and given the challenges other nations are facing from low or negative inflation these days, that’s something to be happy about.

Inflation beats deflation every time

If you don’t think deflation is a risk right now, it’s time to start doing some serious reading about economic outlooks elsewhere in the world.

A recent BusinessWeek report recently dove into the rather bizarre European bond market as a sign that low borrowing costs, coupled with the lowest level of inflation in four years, could signal trouble for the euro zone.

“Past a certain point, falling interest rates go from being helpful to a little scary,” the authors wrote. “An extremely low interest rate can signal that investors have no faith in a country’s ability to grow on its own and that they expect central banks to keep official rates superlow for a long time to gin up economic activity.”

Europe needs to tread very lightly, given the unique challenges presented by the structure of the EU’s fiscal union and the inability of the European Central Bank from engaging in extraordinary monetary moves like quantitative easing.

And beyond borrowing, there is the consumption problem caused by stagnant or falling prices. As companies keep their products cheap to attract reluctant buyers, the result is smaller profits and poor wage growth and, thus, increasingly reluctant buyers — a vicious cycle that is difficult to break.

And it’s not just Europe that is fighting against deflation. Also take a good look at Japan, which is the poster child for a deflationary spiral that holds back economic growth for years.

Japan’s stock market underwent a remarkable resurgence in 2013, with a 57% increase for the Nikkei propelled “Abenomics” finally breaking the shackles of deflation. And, most recently, the country has been celebrating as inflation has come in hotter than expected at the beginning of April.

That’s right: In Japan, they are thrilled that prices are rising faster than expected, given their “lost decade” due to deflation.

The Fed focused on deflation, not inflation, risk

The reality is that, like the EU and Japan, the Fed is — and should be — much more worried about deflation in the current lackluster global economic environment than it is concerned about runaway inflation.

“On its face, flat consumer prices sound like a blessing that holds down household costs. But when tepid inflation is associated with small wage gains, excess business capacity and soft global demand, as now, economists see it as a sign of broader economic malaise that restrains investment and hiring. Exceptionally slow wage and profit gains also make it harder for household and business borrowers to pay off debt.”

That’s right — until inflation moved up, not down. Meaning the CPI jump was just what Janet Yellen ordered.

Of course, this does not mean we are completely out of the woods, as evidenced by the Fed’s continued concern about deflation. Consider that Treasury Inflation Protected Securities continue to offer at barely above break-even, with a $13 billion auction of 10-year TIPS in March netting a yield of just 0.659% — showing market expectations of future inflation are still pretty subdued.

Furthermore, consumer inflation expectations are low when taken in context of historical data. Check out this graph of University of Michigan inflation expectations, which show sentiment very clearly at or near a three-year low to start 2014.

So it seems to me like the most recent CPI report is, at best, good news that deflation is not a concern and, at worst, a sign that we are doing OK but not out of the woods yet when it comes to the threat of falling prices damaging U.S. economic growth prospects.

Now, it’s never great to see prices go up — either at the grocery store because of a lack of rain in California or on your utility bill because of a cold snap or for any other imaginable reason. The bottom line is that higher prices are a drag on consumers, period.

But a bigger drag on the economy is a lack of wage growth, demand for loans, and profits and hiring, as businesses slash prices to win customers.

So don’t sweat the recent CPI surprise. It’s never nice to pay more for produce or propane, but considering Japan’s multi-year struggle with deflation and the specter of similar challenges in Europe … rising consumer prices sure beat the alternative.

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